Many people wonder if they should prioritize between keeping their RRSP savings intact or paying down debt. A common thought is that you should cash in your RRSP to pay off debt. This idea can be a tempting one when you’ve spent too much on your credit cards, have an emergency expense or you’re not able to pay your bills for any reason. It becomes even more tempting if you’ve lost your job or you have a big pile of bills to deal with. However, cashing in your RRSP to pay off debt is typically NOT the best solution.
There are a number of reasons why you may want to consider another debt reduction strategy. One reason is taxes. When you put money into an RRSP, that money is sheltered from taxes. Whenever that money is withdrawn for whatever reason that money will be taxed. You will have to pay what’s called a “withholding tax” at this point, which can be quite a lot of money. If you take up to $5,000 out of your RRSP, you’ll have to pay 10% in taxes. Use between $5,000 and $15,000 and that amount goes up to 20%. If you’re taking out more than $15,000, you’ll need to pay 30%. This means that you’ll need to take out much more than you actually need in order to pay down your debt as you’ll pay a lot of tax on that money.
Another reason to avoid cashing in your RRSP to pay off debt is because the money in your RRSP is meant to be for retirement. If you take it out early, you won’t have that money when you retire. Many Canadians are already worried about saving for retirement. Surveys show that most Canadians feel that they haven’t saved enough in order to retire comfortably and many feel that they’ll have to work longer than they originally planned due to not having enough retirement savings. If you use the money meant for retirement right now, it won’t be there when you’re older and need it. The earlier you start putting money into an RRSP, the more time it has to grow. If you remove what you have saved now, it will be tough to catch up by retirement. One more reason to reconsider your plan for cashing in your RRSP to pay off debt is that most RRSP savings are protected if you file for bankruptcy or submit a consumer proposal. If you end up in a debt situation where you cannot pay your debts as they become due and have to file bankruptcy or consumer proposal, you won’t lose most of your RRPS contributions. Canadian law allows you to keep contributions made more than 12 months ago. This means you’ll only lose those made in the last 12 months, not everything you have.
Other Ways to Pay Down Debt
Instead of cashing in your RRSP to pay down debt, there are other debt reduction strategies. If you are having trouble paying your debts as they become due, you may wish to consider speaking with a licensed insolvency trustee. Do not be scared off by the name. A licensed insolvency trustee doesn’t just help you file for bankruptcy. Instead, a trustee can review your financial situation and inform you of the options available to you that can help you improve your financial situation. Licensed insolvency trustees are licensed and registered by the federal government and trained to provide you with information on all options that are available to you, not just those options that the trustee can assist with. Most trustees offer free consultations. When it comes to paying down your debt, there are a number of different strategies. Each financial situation is unique and, therefore, the solutions that work best are unique to each individual. For this reason, it makes sense that you discuss your situation with a professional (such as a licensed insolvency trustee) who can review your situation and provide you with the information that is relevant to you. You can then use this information to make an informed choice, rather than assuming that cashing in your RRSP to pay off debt is the best option.